Why the law was written
The US Securities and Exchange Act of 1933, also known as the Federal Securities act and the Truth in securities act was enacted on 27th May 1933, as a response to the devastating stock market crash that was experienced in 1929 at which time there was little federal regulation of the offer and sale of securities in the country. At this time, securities were regulated by state laws, otherwise known as blue laws and these were grossly inadequate, as can be attested by the crash.
Stakeholders of the law
The law affected several groups of people. The very first group of people to be affected was the public. People were quite timid with their money after the crash and therefore needed some sort of assurance that their investment would be safe if they placed their money in any securities. The second group was the companies. These were faced with new regulatory expenses which had not bee accounted for and also the ease of raising capital from the public was significantly decreased. The third lot was the local governments. Previously, the regulation of the securities was their responsibility and they therefore had a challenge to align their laws to the new one.
Initial hypothesis
The law brought a positive change in the business environment since there was increased security for the investors, requirement for accountability by the issuing companies and more streamlined regulations from the local governments.
The Securities and Exchange act of 1933
This law dictated that all offers of securities to the public be registered as per the act, unless there exists any exemptions under the law. The overall purpose of the act was to ensure that material information about the companies offering the securities is made adequately available to the public, to enable them make informed decisions about their investment decision. Also, it was aimed at reducing cases of fraud, misrepresentation and deceit in an effort raise more capital from the securities, which was a common practice among financially struggling companies. This act does not however guarantee any redress for loses resulting from investing in securities.
It can only be relied upon to the point that the investor can prove that he made his decision to invest in the company without adequate or with misleading information about the company as a result of a failure by the company to provide the correct or sufficient information. This means that if an investor experiences losses having made his decision with all the information that was possibly available and correct, this is the normal operation of the stock market and no relief is available from the government, (SEC, 2008). By providing the public with correct information, the act not only protects the public from capital losses, but also legitimate businesses from unfair competition by unscrupulous companies.
The Securities and Exchange act of 1934
At this point it is important to make a distinction between the securities and exchange act of 1933 and that of 1934. The latter act was enacted to create the SEC, the Securities and Exchanges Commission, which is responsible for the overall regulation of the securities industry serving functions such as overseeing and registration of all firms operating in the industry, including the SROs, (Self Regulating Organizations). Before the creation of the SEC, the 1963 act was administrating red by the Federal Trade Commission. However, the FTC had too many functions regarding the prevention of unfair business practices such as monopolistic practices and deceptive advertising, and there emerged a need to have a dedicated agency that dealt with the regulation of securities independently.
The process of registration
All securities must undergo the registration process, pursuant with the 1933 act. This process involves the use of pre formatted forms, which is as a result of the government’s effort to reduce the cost of offering the securities (SEC, 2008). The forms require information such as, a description company, in terms of the property owned, type of business conducted, management, and financial reports that have been verified by an independent accountant. As mentioned above, there are some exceptions to regulation by the act. These include offers of municipal securities, offerings to specified people (private placements), those offerings that are limited in size and intrastate offerings. This facility is still aimed at mitigating the cost of selling securities to the companies.
Stakeholders of the act
The act came at a time when investor confidence had all but been eroded by the stock market crash. The government had therefore to take some drastic measures to regain this confidence, if it was to salvage the country’s securities industry. The stakeholders were the primary target of the act were therefore the investing public. The purpose description of the act according to the investopedia.com website is “A federal piece of legislation enacted with two main goals in mind
- to ensure more transparency in financial statements so investors can make informed decisions about investments, and
- to establish laws against misrepresentation and fraudulent activities in the securities markets.”
It is therefore evident that the first group of people that are affected by the act was the public. The second group is invariably the companies offering the securities. They suddenly found themselves with an accounted for expense for complying with the law. Also, there were other requirements that posed a challenge for the companies such as the requirement of an independent accountant’s report of the company’s financial statements.
The registration process also imposed a longer waiting time during which the company could raise finance through the issue of securities. This is not in favour of those companies that are in need of quick capital for example to avert a cash crisis by boosting their working capital balance. The final group of people that was affected the act is the local government. Prior to its enactment, all securities were regulated by the local governments, in what came to be known as blue sky laws (Wisconsin Department of Financial institutions).
These laws, after creation, faced a lot of constitutional questions to the effect that they were obstacles to capital acquisition by companies, but it was then argued that if companies were made to make disclose their statements in public they would probably have more representative information. The third group that was affected by the act was the local governments. Before the enactment of the act, the local government was responsible for the regulation of the issue and sale of securities within their municipality. However there were serious limitations to the effectiveness of the blue sky laws, as evidence by the crash of the stock market in 1929.
There were several approaches that had been proposed to the regulation of securities, and actually several had been adopted by several states, resulting in disunity among the regulatory frameworks within the entire country. With the enactment of the act, the local government had to adjust their own laws to accommodate the provisions of the new law so as to remain relevant. The blue sky laws were still in use among the exceptions of the 1933 act, and therefore they had to have some sort of standardization, which had to be done by the local authorities.
Efficacy of the act
The efficacy of the act can be assessed by measuring the success of the organization that was charged with the implementation of the act in relation to its objectives, the SEC, that is how much of what was intended in its creation has been achieved so far. The primary objective of the act was the protection of the investing public and the restoration of public confidence in the securities industry, especially after the market shock of 1939.
The success of Securities and Exchanges Commission as far as this is concerned has been phenomenal This is evident from the fact that the United States Stock Market recovered though slowly at first, almost fully and by the 1950s was the most dynamic financial instruments market in the world. This is a direct indication that investor confidence has not only been restored but has also been boosted as more and more companies seek capital from the public and people increasingly invest in public securities. As far as the goal of reducing cases of misrepresentations and corporate deceit is concerned, the SEC was granted powers to enforce the actions it recommends on the fraudulent businesses.
The commission brings hundreds of actions against individuals and companies that violate security laws, having committed such offenses as accounting fraud, misleading securities information and insider trading. The commission relies heavily on investors to provide information about the security laws violations, which raises the question of the importance educated investors, to which end the commission provides educational resources on their website such as the disclosure documents, which display in detail the requirements of the law as far as corporate disclosure is concerned. Another approach that we can use to evaluate the efficacy of the act is by looking at the effect it has had on the stakeholders. We shall look at the effect one at a time.
Investors
The effect that the act has had on the investors is profound. Not only have their faith in the securities industry been returned, they have also been sensitized on the procedure of securities registration, so that they are more able to make safer decisions about the securities to invest in and also to detect and inform the SEC on any malpractices.
Companies
With the requirements of the act including public disclosure of financial performance results, companies have designed and implemented systems aimed at improving the level of accountability in the organizations, which have resulted in better corporate performance. By having stringent registration procedures thereby reducing the number of fraud cases, the act has all but eliminated unfair competition from unscrupulous businesses. Business can only raise additional capital from public issues if they satisfy regulatory requirements and therefore there are fewer cases of fraud.
Local authorities
Municipal authorities have also benefited by having a unified system of regulation for all national wide security issues, which has addressed concerns about differing security laws across states, which was a problems when the blue sky laws were in use. Also the act forms a basis on which local security issue laws may be formulated.
Implementation
The implementation of the Securities and Exchanges act rests with the Securities and Exchanges Commission (SEC), which was created by The Securities and Exchange act of 1934, after it was determined that the regulation of the securities industry, which was at the time under the docket of the Federal Trade Commission (FTC), needed to have a separate and independent body to handle the treatment of the process of issuing the securities.
This was because the security industry is maintained by the faith of the investors and any loss of this faith will result in a diminishing of the capital that is available for companies from the public. While the FTC was concerned with among other things consumer protection and preventing of irregular business practices, the SEC was left to concentrate on issues related to the issues and sale of securities, such as ensuring that all the requirements of the 1933 act are strictly adhered to and recommending punitive actions for individuals and corporations that violate these provisions.
From the SEC website, it states it’s already discussed objective of protecting investors in stocks, bonds and other securities which unlike bank deposits which have the guarantee of the federal government, securities can lose value which puts investors in a very precarious position. The SEC undertakes to administer the law under one basic premise that is all investors should have access to some form of basic information about the security they are considering purchasing, irrespective of whether these investors are large institutions or private individuals. Under the regulation of the SEC are organizations such as security exchanges, investment advisors, mutual funds and also brokers and dealers.
Though the SEC has no powers to impose any sanction a company that has been found guilty of engaging in security related fraud, it can and does recommend these sanctions in a court of law and most of the times they are considered and implemented by the same. Examples of violation of the securities laws are as discussed above, and include insider trading, misreporting of financial information and information about securities. Information that the SEC uses to regulate the industry primarily comes from the public, which is the reason why the commission strives to provide educational information, so that the investors can know what to look for so as to detect and report suspected fraud.
The SEC is organized into five commissioners; all appointed by the president, who also designates one of the commissioners to be the chairman of the commission, its chief executive. The terms of the commissioners run for five years, and the law stipulates that commissioners from the same political party should not exceed three, in an effort to promote equity and remove bias. The Securities and Exchanges Act of 1933 was created by congress as a guideline and framework and since the markets and securities are constantly changing both in diversity, technology and size, there is need for the SEC to engage in rulemaking, the process of which takes several steps as explained below:
The concept release
This is where the SEC identifies a problem and in recognition of the need for public feedback in the numerous and often complex policy problems. The commission therefore prepares a document that outlines the problems and some possible solutions and finally ends with a few questions for gathering input from the public before deciding on the course of action.
The rule proposal
After the concept release stage, the commission then advances to the rule proposal stage, in which the public opinion is sought again, only that this time the document that is given to the public contains a lot more details, specific objectives and methods of achieving the objectives. The proposal contains a lot of elements that will finally end up in the final document.
The rule adoption
This is the final stage. Once the commission is satisfied that the rule has been extensively debated by both the public and the commission, it is presented to the commission for voting. If it passes the vote it becomes one of the rules governing the securities industry. The Commission is organized into four offices. The commission is empowered to among others the interpretation, amendment and creation of new security laws, coordinate the operations of all the government offices that are concerned with the securities industry. As mentioned above, the SEC is divided into four, the corporate finance division, the trading and market division, the division of investment and the division of enforcement. We will look at each of these divisions individually.
Corporate finance division
This is the division concerned with corporate disclosure. It’s duties among others is the ensuring that all public companies comply with the law’s requirements as far as disclosure is concerned at the initial offering, and also during subsequent routine disclosure that are also a legal requirement. It is this division that is also assists corporation with interpretations of the rules that it administers so as to make compliance easy. The corporate finance division liaises with the stakeholders of the accounting profession to ensure that all companies that are registered (public) adhere to the prescribed accounting regulations.
Trading and Markets division
This division is responsible for the day to day regulation of market activities with the aim of ensuring efficiency, orderly and fair trading. Apart from overseeing the major players in the securities such as stock exchanges, investment advisors etc, this division also oversees and administers the Securities Investor Protection Corporation (SIPC) which is a not for profit organization that seeks to protect the wealth of investors in case the dealers that hold their stocks were to collapse.
Among the duties of this division include the duty to assist the commission in formulating of new rules, carrying out integrity check for all the stock brokers that are registered and to ensure their financial soundness thus preventing any loss to investors should they collapse. It is also involved in the review and even implementation of rules and regulations that are suggested by the self regulatory Organizations (SROs).
The investment management division
This division manages the investment management industry by providing the framework and guidelines for protection of the investing public and promoting the formation of capital from public issues. The people who are regulated under this mandate include mutual funds and the professional fund advisors that advise them. Like all the other divisions of the SEC, this division is concerned with the interpretation of the rules and regulations concerning the SEC. It is also concerned with the reviewing and the investment company and investment advisor reports that are presented to the commission. It also advises the commission on new rules to adopt and which of the existing ones to change for the SEC to remain sensitive to changing situations.
The enforcement division
This division is responsible for the recommendation of commencement of investigation of any violation of security laws, by bringing a civil action in a federal court or administrative law judge, and also prosecuting the cases on behalf of the commission. This division works closely with other law enforcement agencies within the country and without, as the case may dictate in the investigation and prosecuting of the offenders. Sources of evidence for this division are diverse but as mentioned before the most important source is the tips that come from investors, since they have direct contact with the market.
Other sources include market surveillance, media reports, other SEC offices and self regulatory organizations. The investigation is conducted privately and may include interviews, trade data reviews, examination of books of accounts among others. Once it is established that the evidence that has been compiled is sufficiently extensive, the evidence is presented to the commission for review after which it may approve its staff to initiate a court case against the offender or to bring an administrative action.
The difference between the civil action and an administrative action is that while the former is heard in a federal court, the latter is heard before an administrative judge who is independent of the commission. The court made issue court orders to the effect of dis-engorgement, which is the return of illegally obtained profits or monetary penalties. When the administrative judge gives his judgment, the commission may either accept it and proceed to determining the punitive measures to be taken, or it may reject it and refer it for further deliberation. Often the dispute is settled outside of the court or before a judge between the guilty party and the commission.
Evaluation of the act
The evaluation of this act involves the consideration of the issues that the act was meant to address, its methods through which the issues were to be addressed and its success so far in addressing these issues. The act, having created in 1933, came as a response to the devastation of the 1929 stock market crash, which was wholly attributed to laxity of the regulation of the securities industry prior to the crash, and at the time since the country was enjoying the post war prosperity every one went into investing headlong so as to get rich overnight (The State of Wisconsin Department of Financial Institutions, 2008) Companies, capitalizing on this unprecedented demand also decided to cash in and even companies that neither had the capacity to issue shares no the need for the extra money went ahead and did so and once the securities started losing value it was downhill.
Almost half of all the stocks that were purchased became worthless spelling disaster for the investors and the banks and other financial institutions that had lent them the money to invest (Kindelberger, 2005).
Congress, in an effort to save the country’s securities market and return the ease of capital formation to its earlier state, set out to debate formulate rules and other ways of regulating the industry so as to avert the occurrence of the same scenario in the future. Thus the 1933 law was enacted. At the time, it fell under the docket of the FTC and it was felt that there was a need for a separate agency to handle the numerous complexities that entail the regulation of a dynamic industry such as the securities industry.
This was effected in 1934 by the establishment of the Securities and Exchanges Commission (SEC). One of the indicators of the success of this commission in achieving the act’s objectives is that there has never again been experienced a stock market crisis of the magnitude of the one of 1929 and as a matter of fact, the United State has been experiencing of the fastest capital growth in the world, with only the minor fluctuations of recessions and booms periods that are common to all capital markets. According to Henry, M. Paulson Jr, who is the Treasury Secretary of the US, the American capital markets currently rank first globally in terms of efficiency, transparency and depth. All this can be partially if not totally being attributed to the action of the provisions of the 1933 act and the efforts of the SEC.
There has also been a tremendous boost to investor confidence as can be attested by the high level of investment that was witnessed during the 1990s and the internet revolution when all ‘silicon valley’ companies were putting a lot of funds into the research and development of products that were primarily targeted at the internet users, though the internet technology was relatively new this did not deter the investors and a lot of capital was raised. Most of these companies required the assistance of venture capitalists, who are usually very cautious about the investments that they make.
Most of the ‘Dot-com’ companies as they came to be popularly known at the time had business models that dictated operations that led to large losses in the initial years and sometime even no revenue but still investors put their money into them. The pay off from these investments are best described by a venture capitalist as follows, “the dramatic increase in the value of technology stocks during the internet boom is the greatest legal creation of wealth in human history” (Varian, H. 2004)
Ethical issues
Some of the ethical issues that surround the Securities and Exchanges act of 1933 include the perceived government curtailing of corporate freedom to raise capital, investor freedom to make their own individual choices. For the first issue, the United States Supreme court ruled on the following grounds, “Those who are forced to undress in public will presumably pay some attention to their figures.” (The State of Wisconsin Department of Financial Institutions, 2004)
This is to say that companies by being required to comply with specific regulations as far as financial reporting and presentation of the securities information are not being discouraged from seeking capital from the public,. Only that they are being encouraged to be more open and honest to the public, which in turn will have more confidence in the market thus making even more capital accessible to them.
As far as the second constitutional issue is concerned, as has been quoted above, congress does not take away the universal right for every individual to make the wrong decisions, rather it intends to make sure that all the mistakes that the public make are the sole fault of the public investors and due not accrue from the malpractices of the companies issuing the securities. This fundamentally protects the investors and the companies themselves as all investors are constantly aware of the risk that is inherent in the stock market and can therefore attribute tier losses to their own poor investment decisions therefore maintaining the integrity and transparency of the securities industry.
Recommendations
The only recommendations that are probably appropriate is the improvement of the SEC’s educational function as it is quite easy for potential investors to get disillusioned by losses they may incur from the market, whether they are caused by their own or the company’s fault, which results in timidity on their part and this greatly reduces the availability of capital for the companies.
Also the government can still do more as far as maintaining the competitiveness of the United States securities markets as has been remarked by the US chamber of commerce during the launch of the Center for Capital Markets Competitiveness (CCMC) where it was identified that the sustenance of long term economic growth is directly dependent on the availability of capital for entrepreneurs to start up business and for existing business to expand their operations and in the process create jobs and new innovative products.
Works Cited
Varian, R. Farrell, J and Shapiro, C (2004). The Economics of Information Technology. Thompton, California.
The State of Wisconsin Department of Financial Institutions (2008). A brief history of securities regulations. Web.
The US Securities and Exchanges Commission (2008). How the SEC protects investors. Web.
Investopedia.com (2008). The Securities and Exchanges Act of 1933. Web.
United States department of the treasury (2007). Opening Remarks by Treasury Secretary Henry M. Paulson, Jr. at Treasury’s Capital Markets Competitiveness Conference. Georgetown University. Web.
United States chamber of commerce (2008). Strengthening the Capital markets fro investors and entrepreneurs. Web.
Obstfeld, M (2004). Global Capital Markets: Integration, Crisis, and Growth Cambridge university press.
P, Kindelberg (2005 ) Manias, Panics, and Crashes: A History of Financial Crises. Wiley, 5th edition.